Cut in interest rates brings Ireland nearer to euro level

The second big reduction in interest rates in less than a month means we are now almost ready to enter the single currency.

For the second time in recent weeks the Central Bank surprised the markets by making a large cut in interest rates, bringing rates here lower than in Portugal or Italy and very close to German rates.

The 1.25 percentage point cut means that the base Irish wholesale interbank rate is now at 3.69 per cent, compared with 4 per cent in Italy and 3.75 per cent in Portugal, while Spanish rates now stand at 3.5 per cent. All these countries must cut rates to the German and French level of 3.3 per cent by the end of the year in order to be ready for monetary union.

There has been intense speculation about when the Central Bank would cut rates - only last weekend its governor Mr Maurice O'Connell said in a RTE interview that he would prefer rates to stay high for as long as possible. However, as analysts like ABN Amro's chief economist Dr Dan McLaughlin point out, the Central Bank has been coming under pressure form the European Central Bank to cut for some time.

This week the ECB president, Mr Wim Duisenberg, was reported as saying he would be aware of the timing of rate cuts in peripheral countries and, as Goodbody Stockbrokers' chief economist Mr Colin Hunt points out, the matter would have been discussed at the ECB council meeting in Frankfurt on Tuesday which Mr O'Connell attended.

That day both Spain and Portugal cut rates, while Italy did so only last week, in the run-up to the meeting. Some analysts also point to the proximity of the Irish rate cut to the British on both the last two occasions, but others insist this is simply coincidental and there is no larger significance to it.

It is clear the Bank does not want to cut rates and would much prefer to be increasing them sharply to try to calm the housing market. It posted a note on its electronic market site that the rate cuts were in preparation for monetary union. In other words, it would not be cutting rates if it did not have to for external reasons.

The reasons for the bank's reluctance to cut rates are clear, with the economy booming and inflationary pressures in the housing market and in parts of the jobs market. On Thursday, the latest figures showing total lending from banks and building societies indicated that credit growth remains strong.

Many analysts had expected the Bank to wait for October inflation data - which may show a further moderation in the consumer price index - to be published, before it cut rates. However, the publication was put back seven days to November 17th That would have meant another week before an announcement would have been made and that may have been just a little too late.

The Bank is also likely to have been worried about another set of data released yesterday, which showed that hourly earnings in manufacturing increased by 7 per cent between June 1997 and this year, over double the rises agreed in Partnership 2000. This provides further evidence of inflationary pressures and could also act to undermine competitiveness.

The size of the latest cut has also surprised most observers. The last reduction brought us just below the Italian rate and this time it also looks as if the reduction could have been designed to make sure that we are no longer at the top of the table. Moreover, as Mr Hunt points out, delaying rate cuts would have no effect on inflationary pressures, as they are completely expected at this stage.

The banks and building societies will now follow the Irish Permanent and begin announcing further variable rate cuts. Generally with an expected interbank rate of 3.3 per cent, variable mortgage rates could be expected to be around 4.8 per cent.

However, most banks say privately they are planning to keep these interest rates above 5.5 per cent, unless they are forced to move lower by competitive pressures. This is a move to protect their profit margins, as there is very limited room to cut savings rates from already low levels.

Market analysts expect the next Irish interest rate cut of 0.39 of a point in the first week of December. This is because the Bank is likely to want to get it out the way before people start closing off their books at the end of the year and because of the whole uncertainty surrounding conversion to the euro which is bound to be prevalent at the end of the month.

From next January, control of interest rates will move to the European Central Bank, which is under pressure from the French and German governments to reduce base euro interest rates even further from the current 3.3 per cent level